Health Savings Accounts Cure Patients of Blind Consumption


abq_journalThose who advocate the nationalization of the American health-care system often cite the trend of rising national health expenditures as percentage of gross domestic product. From 1960 to 2000, health care’s share of GDP in the United States increased from 5.3 percent to 13.2 percent. Rising personal income, higher quality care and insurance that insulates individuals from health care’s real costs are the main factors behind this trend. From 1960 to 2000 real GDP per capita, has increased from $13,155 to $32,670 (expressed in 1996 prices). During the same period, real GDP per capita devoted to non-medical services increased from $12,458 to $28,3588. Put differently, the so-called explosion in medical-care expenditures reduced the average annual rate of growth of real GDP per capita devoted to non-medical goods from a potential 2.30 percent to 2.08 percent.

American consumers are wealthier than ever: The more than doubling over four decades of real GDP per capita excluding medical expenditures is reflected in real consumption. The “explosion” in medical-care expenditures ate a bite of our salad, but hardly the whole lunch. And for that increase in health spending, we receive better high-tech care that was not available at any price in 1960.

In that light, the present looks pretty good. The future looks even better, mainly due to the surge of American productivity and the Health Savings Account Act that President Bush signed into law in 2003.

Traditional medical insurance covers two dissimilar events: minor ailments and catastrophic illnesses. If a consumer faces a 5 percent probability that she will contact a catastrophic illness in a given year requiring $20,000 of medical care, she would be willing to purchase a policy for $1,000 (plus transaction costs). She will not use more of the heart-surgeon’s services just because her out of pocket spending is zero.

This consumer also faces some probability of suffering the run-of-the-mill headaches, sniffles, backaches etc. Assume that she would be willing to purchase a policy for additional $1,000 for sniffles, etc. Under the tax law she is allowed to exclude $2,000 from her taxable income. Her demand for care for minor illnesses is inversely related to price: At the true high price she would consult the medical encyclopedia and use over-the-counter drugs. At a low price- zero if her insurance pays the entire cost- she would consume much more care.

The problem with the prevailing medical insurance is that the third-party payment of health care bills insulates the consumer from the real costs of medical care services for non-catastrophic illnesses.

The new Health Savings Account law basically allows the consumer in our example to set aside $1,000 in an HSA that is tax exempt, and can be used for sniffles and headaches at her discretion. If this year she spent only $300, she can use the remaining $700 for next year’s sniffles, or save it for retirement.

HSAs thus eliminate “moral hazard” by separating catastrophic from minor illnesses and injuries. Additionally, it is designed to enhance competition by eliminating managed-care-third-party restrictions. It is also likely that availability of HSAs would induce many of the uninsured to insure.

Furthermore, under the HSA law, it behooves our individual to convert a high-cost-$2,000 premium, low-deductible policy into a low-cost-$1,000 premium, high-deductible policy. Before the HSA option was enacted, such a transition would have resulted in a loss; turning the $1,000 premium saving into taxable income would have resulted in a loss of roughly 40 percent (income and payroll taxes.) But now, the individual can use the sum of $1,000 to fund a health savings account, and the contribution to this account will be fully deductible, whether she itemizes deductions or not.

Because of the contribution of the new HSA law to competition and efficiency, the next four decades look even brighter than the previous four.

There are two additional legislative modifications that should be initiated at the federal level in order to further reduce the future costs of medical care:

  • Congress should change the Medicaid formula for matching state funds to making block grants. With block grants, states will have stronger political incentives to distribute Medicaid money more efficiently.
  • In July 2003, the U.S. Senate could not muster the 60 votes needed to pass the medical liability reform to cap medical malpractice damage awards. They should try again, because such a reform would go a long way to reduce the cost of physicians’ services all over the United States.

The New Mexico Legislature removed the gross-receipts tax on payments to physicians from commercial managed care companies. But, the gross-receipts tax will continue to be imposed on the kind of out-of-pocket medical expenditures that would be made from health savings accounts. The 2005 Legislature should remove that vestigial gross receipts tax, an act that will make HSAs more attractive to consumers and help attract more physicians to New Mexico.